ASK THE FOOL Get to know capital structure
Calculating inflation
Q. Can you recommend a good inflation calculator?
– C.A., Reno, Nevada
A. Sure. Click over to Westegg.com/ inflation, enter two years, and you can see how prices changed between them – for example, something that cost $100 in 1999 would have cost $156 in 2019. To learn the average inflation rate over a period, visit Measuringworth.com/inflation. (Between 1999 and 2019, for example, it averaged 2.16% annually in the U.S.) That site also shows inflation rates for specific years. Inflation was close to 0% in 2015, but topped 13% in 1980! Since the beginning of the 20th century, inflation has averaged roughly 3% annually.
Q. Can I give certificates for single shares of stock as holiday gifts?
– G.R., Mount Pleasant, South Carolina
A. You can, but you may not want to. Giving a young person a stock certificate can be a fun way to introduce them to investing, but in this digital era, many companies have phased out paper certificates. You can still ask the company or your broker for a paper certificate, but it will cost you – possibly a lot.
Some websites will offer to sell you certificates for single shares of stock, but they may charge you twice as much as the share actually costs (or more!), and there’s a good chance you’ll just be getting a replica of a certificate. (You’ll also get paperwork confirming that you do own that share.)
When assessing a company as a potential investment, for best results, you should study its business deeply. Among other things, it’s good to understand its “capital structure.”
A company’s capital structure is how it finances its operations – using cash, debt financing (borrowing from a bank; issuing bonds) and/or equity financing (selling a chunk of the company; issuing shares of stock).
Imagine that Scruffy’s Chicken Shack (ticker: BUKBUK) is financed mainly with debt, paying 5% in interest on its loans. If it’s reliably growing its earnings by about 10% annually, that debt seems manageable. The interest rates companies pay depend on their credit ratings: Healthy companies are offered low rates, and shakier ones are stuck with higher rates.
Alternatively, Scruffy’s might finance itself by issuing stock. This is an especially attractive option during bull markets, when its shares will likely trade at high levels, allowing it to get more money for each share issued. That’s great, but every time the company issues shares, it’s diluting the value of the shares that existed before. (This extreme example will show why: If you owned 15 of a company’s 100 existing shares, you’d own 15% of the company. But if it issued another 50 shares, your 15-share stake would shrink to 10% of those 150 shares.) Dilution is only OK if the money raised helps the company increase its market value enough to more than offset the drop in value for existing shareholders. When a company becomes cash-rich, it can buy back shares, reducing that share count and thereby rewarding shareholders.
Finally, Scruffy’s might opt to grow only by using cash generated from its operations. That can be less risky, but it can create slower growth. Remember, too, that many successful companies were unprofitable in their early years – cash isn’t always plentiful. And rivals using equity or debt financing might grow faster.
Companies often use a combination of debt, stock and cash financing. The debt-to-equity ratio, which divides total debt by shareholder equity, offers insight into how companies finance themselves.
MY DUMBEST INVESTMENT Bad pundits
My dumbest investment was moving conservative investments into my company’s stock, based on the recommendations of investing pundits. The stock tanked shortly after that. – J.G., online
The Fool responds: It’s easy to assume that investing pundits you see on TV, online or in print are highly stocksavvy and bursting with profitable investment ideas for you. But the truth is that they vary widely in investing skills, insights and performance – and it can be hard to know just how worthy of your attention they are.
It also might have seemed smart to park much of your money in the stock of your employer, since you’re more familiar with that company than just about any other. Remember, though, that you’re already depending on your employer for your current financial needs; your salary is paying for your housing, food and much more. If, on top of that, you invest much of your long-term savings in your company, you’re keeping a lot of your eggs in a single basket. Should the company fall on hard times, you might lose your job – along with much of your retirement savings. Plenty of seemingly solid companies have seen their fortunes change for the worse.
Aim to spread your long-term dollars across a wide range of investments in which you have confidence. Or just stick with a low-fee, broad-market index fund, such as one based on the S&P 500.
FOOLISH TRIVIA Name that company
I trace my roots back to 1843 and 1910, when the founders of two companies got their starts – respectively setting up a hardware factory in New Britain, Connecticut, and a machine shop in Baltimore. Those companies would eventually merge in 2010. Today, with a market value recently near $27 billion, I employ more than 60,000 people in the world’s largest tools and storage business. I’m also involved in electronic security services, infrastructure, oil and gas – and even health care. My brands include Bostitch, Craftsman, Dewalt, Irwin, Lenox, Mac Tools and Porter Cable. I’ve paid dividends for 144 consecutive years. Who am I?
Last week’s trivia answer
I trace my roots back to 1985, when a Sears employee tested a new credit card. A year later, Dean Witter Reynolds, then a financial services subsidiary of Sears, debuted that card. It was unusual because it charged no annual fee, sported a higher-than-average credit limit and offered cash rewards to users. That card is under my roof now, and its name is part of mine. Today, with a market value near $21 billion, I’m one of America’s largest card issuers. I offer banking services, too, and charge no fees on deposit products such as checking accounts. Who am I? (Answer: Discover Financial Services)
THE MOTLEY FOOL TAKE Calling Verizon
Telecom company Verizon Communications (NYSE: VZ) is an intriguing option for income-seeking investors. Like most investments, it’s not perfect: It’s saddled with $113 billion in debt, thanks in part to the capital-intensive needs to build and constantly improve communications infrastructure. Purchases of now-struggling assets from AOL and Yahoo! a few years ago didn’t help the balance sheet, either.
But in today’s economy, wireless connectivity is a basic staple. Despite the ongoing pandemic, Verizon’s operating revenue fell only 3% during the first half of 2020. The company is also acquiring prepaid wireless specialist Tracfone, which will bring in millions of new customers to whom Verizon can cross sell other products and services.
Verizon stands to benefit from the growth of markets for 5G, the latest global wireless standard. The company’s Ultra Wideband network is available in parts of dozens of cities, with many more on the way. Its new-andimproved technology promises “seamless 4K streaming” along with “ultralow lag on all your connected devices.”
Verizon’s dividend recently yielded a substantial 4.4%, and that payout seems safe, at only 56% of recent annual earnings. The company has ample room to continue making network improvements and service debt, while rewarding owners of its stock generously. Don’t expect any sizzling stock price performance from Verizon, but this slow-and-steady telecom business is still worth owning. (The Motley Fool has previously recommended Verizon Communications.)